It is typical for insurance policies to include conditions which entitle an insurer to reduce a claim payment by the amount of any input tax credit to which an insured may be entitled. In early 2013, Dalton J of the Supreme Court of Queensland1 considered that where the amount of the claim exceeded the sum insured, the amount to which an insured was entitled was the sum insured less the notional input tax credit. The decision created somewhat of a stir because it meant that where the loss exceeded the sum insured, the insurer could never be required to meet its contractual promise.
The Queensland Court of Appeal recently revisited this issue.2
The insured owned a building which was insured under a commercial business insurance policy covering loss and damage to building and contents, debris removal and business interruption. The total sum insured was $2.1 million. The building was totally destroyed by fire with the loss exceeding the total sum insured.
General condition 16 of the policy was in the following terms:
‘Calculating claims If You make a claim under this Policy, any payment or supply We make to You in respect of the acquisition of goods, services or other supply (or monetary compensation in lieu thereof) or otherwise in relation to Your claim will be calculated on the GST inclusive cost of Your claim.
In calculating such payment, We are entitled to reduce it by any ITC (input tax credit) which You are, or would be, entitled to: (a) for the acquisition of such goods, services or other supply; or (b) had the compensation been used to acquire such goods, services or other supply.
However, the total of all payments We make to You will not exceed Your sum insured, limit or sublimit of liability, or other monetary limitation.
The sums insured, limits and/or sublimits of liability, or any other monetary limitations are inclusive of any tax, levies, duties or charges that the payment would be affected by or subject to …’
Indemnity was confirmed, but relying on general condition 16 the insurer reduced the payment by one-eleventh to reflect the input tax credit to which the insured was entitled.
The insurer argued that where the claim exceeded the sum insured, the correct approach was to first reduce the claim to the sum insured (being the maximum amount to which the insured was entitled under the policy) and then deduct the notional input tax credit from that amount.
The insured argued that general condition 16 required the notional input tax credit to be deducted from the total loss. If the remaining amount exceeded the sum insured, then the insured was entitled to receive the total sum insured from the insurer. That construction was said to be consistent with a policy which capped the insurer’s liability to the sum insured.
First instance decision
At first instance, Dalton J accepted the insurer’s construction on the basis that it was ‘conceptually more sensible’ and produced consistent results irrespective of whether:
- The insurer chose to reinstate the property or pay out the claim; or
- The claim was above or below the sum insured.
His Honour was troubled by the fact that the insurer’s construction meant that the insurer could never be called on to pay the sum insured. However, ultimately he considered that those concerns did not outweigh the commercially sensible result produced by the insurer’s construction.
The insured appealed.
In allowing the insured’s appeal, the Court of Appeal considered that the ‘more natural construction’ of the policy is that the insurer’s liability extended to the sum insured. In reaching that decision the Court of Appeal noted that:
- The ‘claim’ referred to in general condition 16 was not a claim for an identified amount (i.e. the sum insured) but rather the insured’s demand for indemnity;
- The first sentence of general condition 16 described the starting point of the calculation, being the GST inclusive cost of the reinstatement;
- The second sentence of general condition 16 entitled the insurer to deduct from that amount the notional input tax credit payable in respect of the reinstatement; and
- The sum insured had no bearing on that calculation and only applies as a cap where the result of the calculation would require the insurer to pay more than the sum insured.
The Court of Appeal ultimately concluded that:
‘… the construction adopted by the trial judge produces the result that the limit of the insurer’s liability to satisfy its obligations under the policy by payment to the insured is not the Sum Insured stated in the certificate of insurance in simple and unqualified terms, but is instead 10/11ths of that amount. That is such a surprising result as to suggest that the construction which produces it could not reflect the intention of reasonable contracting parties. Furthermore, for the reasons given earlier the appellant’s construction of General Condition 16.2, that the insurer’s maximum potential liability after taking into account input tax credits extends to the Sum Insured, more closely reflects the text and structure of that clause in the context of the policy as a whole than does the construction which the trial judge preferred…’
At first glance, it is easy to understand the court’s attraction to the insured’s argument - it holds the insurer to the bargain to pay the total sum insured. Furthermore, although it does not appear to have been raised at trial or on appeal, it is likely that the premium was calculated and accepted based on a percentage of the total sums insured, not the total sums insured less the notional input tax credit. To then argue for a construction where it can never be called on to pay the sums insured is somewhat incongruous.
That said, any commercial contract should be construed so as to produce consistent results. As noted by the trial judge, the insured’s construction resulted in a situation whereby an insured whose claim exceeded the sums insured is in a better financial position than an insured whose claim is less than the sum insured. While the Court of Appeal justified its decision by saying that the consequences considered by the trial judge were anomalous and only occurred in the case of under-insurance, that the insured’s construction had the potential to produce inconsistent results is still disconcerting.
It seems clear that when the claim exceeded the sum insured, the insurer intended that the starting point of the adjustment was the sum insured from which any applicable input tax credit should be deducted. Unfortunately, as noted by the trial judge, general condition 16 was infelicitously drafted and marked by poor word choice and a lack of conceptual clarity as a matter of ordinary English.
It is but yet another example where clear drafting would likely have avoided what has clearly been a lengthy and expensive process.